Idiot taxes mean business opportunity

A while back I wrote about Dick Smith being a stupid place to buy stuff.

The cheapest HDMI cable you can buy on sale at Dick Smith, with the 15% discount, is a staggering $55.23.

Despite a Dick Smith staff member’s comment on the post

“I work there and I will admit you can get pretty much anything we sell cheaper on the internet”

…Amnon, amongst others, commented that there are in fact some things that are cheaper to get from DSE, but it still leaves the mystery of the $55 HDMI cable.

Now from an interesting source comes an answer – and it makes sense. DC based political blogger Matt Yglesias picked up on the notion that the HDMI cables are an idiot tax (or information tax). Actually Matt got that from Alex Tabarrok:

My best guess is that this is an unusually strong version of the hidden fee model of Laibson and Gabaix. In that model, firms overprice one aspect of service–such as a hotel charging exorbitant rates for telephone service–as an idiot tax. Crucially, the idiot tax is matched by an IQ-subsidy; the price of the hotel room is lower than it would be without the idiot tax–so the idiots don’t know to shop elsewhere and the high-IQ types are, in fact, drawn to stores with an idiot tax. Thus, buy your blu-ray player at places such as Best Buy which sell a lot of expensive cable as well as massively overpriced extended warranties.

I’d extend that, and see there are three reasons that people pay these prices:

1. Convenience: Buyers know the price is unfair, but chose to pay as the difference in price is made up by the convenience of buying the item in store.
2. Information: Buyers don’t know that the prices are unfair – as they are unaware of the either because they do not now the prices elsewhere.
3. Coercion: Buyers know the price is unfair, but pay the price as they feel that they have no other option.

Let’s examine these in turn, but first let me state that any business that treats their customers as uninformed or coerces them into buying things should understand that the idiot is not the customer, but themselves.

1. Convenience

This is actually fair – if the extra price a store charges for an accessory is more than compensated by the convenience of obtaining that item immediately, then buyers can make a rational choice. This is a form of price discrimination – a time rich and money poor student may choose to shop around, while a harassed business person in a suit may choose to pay the premium.

It’s critical, however, that the difference in price is not excessive, as then the situation can easily move into the third category of coercion.

2. Information

This is screwing the customer. The store has deliberately chosen to take advantage of the naivety of their shoppers and is taking excess margin.

While this win-lose transaction works at the cashier, stores should realise that in the long run the information will emerge. This manifests itself in a gradual erosion in the public perception of the store. In marketing speak – this is brand erosion, in business speak this is falling sales and eventual bankruptcy.

3. Coercion

This is clearly screwing the customer, with the full knowledge of the customer. Assuming the customer has not walked away this coercive approach results in much faster brand erosion through word of mouth and publicity. The customer experience is negative and they do business with the seller under duress. This is clearly unsustainable.

Where industries contrive to collectively screw customers they open themselves up to a new competitor that breaks the rules and offers customers a straight deal. Indeed all of these approaches carry that risk. Let’s look at some example industries, and how a new player could take advantage.

Convenience Stores and service stations charge more for basic items as you will pay more to get it 24/7 and in an easy location. There are plenty more examples of the 1: convenience category.

Existing store chains can be out competed by mid-small sized supermarkets – much like the metro markets in London or downtown Wellington. There is also room for a service station chain to lower prices of key products and promote that as a competitive advantage. Finally the 24 hour supermarket with service station attached completely changed the industry – reducing the need to c-stores and taking big chunks out of petrol station margins.

Electronic retailers like Dick Smith place low margins on the flagship products, such as TVs and DVD players, and then makes up margin by selling HDMI cables with 80% markup, pointless warranties and so forth. The warranties and HDMI cables are un-buyable as it is clear that there is to much excess profit involved. This falls into the 2: or 3: categories above – as the price difference is just too high to be otherwise.

These old players are being out-competed by e-commerce players with low overheads, knowledge driven selling (i.e. great descriptions) and competitive pricing, cross checked by price search sites. There is little excuse for using something else these days.
There is space, perhaps, for a fairer high street seller, but it’s a tough game with tiny margins – and those rents and staff costs are not cheap.

Hotels advertise expensive rack rates, but offer cheaper ones on websites and through package operators. They charge extortionate rates for telephone calls, internet access, meals, drinks and for mini-bar purchases.

The result is that the smart hotel consumer avoids all of these extras, meaning that they actually have negative utility – the mini bar tempts you but you dare not indulge. These fall into the 3rd, coercive, category – but most chose not to pay.
There is room, and some are addressing it, for a fairer hotel approach. Charge reasonable fees for the phone, minibar and suchlike and people will start actually using them. In NZ we have always had motels, which (unlike the South American definition) are cheap, cheerful and generally fair with the extras.

Rental car agencies add airport fees, taxes and most importantly, insurance costs to their initial quotes. In NZ we have it a bit better, but the sales pressure to lower the insurance excess remains – avoid this as it is a ripoff. Don’t start me on the “free fuel – return it empty” scam either. Many (too many) people fall for this – make no mistake it’s in the 3rd category, and you should not pay.

A new play in Spain (and sadly I can’t find them) completely transformed the expat rentals a few years back by offering a one price, full insurance included, sign and drive away service that acquired customers for the agencies. Other approaches include the rent a car for an hour places like ziphop.co.nz or zipcar.com, or (please) a new rental player that charges one price, full insurance and provides instant service without 10 minutes of typing into an archaic green text screen.

Mobile Telephone providers ‘fight’ on their headline calling plans, but charge high prices for international calls, international roaming, excessive texts, minutes and in particular international data. With very few exceptions these rates are not reducible – and so international data roaming in particular is simply unusable.

The mobile telephone companies have a grip on the market – but resellers and new players like NZ’s 2degrees have the ability to be somewhat transformational by offering one price for all you can eat deals. 2degrees is stuffed on international roaming though, as these prices are dictated by the counter-party. However Vodafone has the ultimate opportunity to simply make international roaming data, voice and text fees disappear for their customers – and they’d have a lot more customers if they did so.
Customers have voted with their feet on telecos – and have moved across to Skype, especially for international calls. When the marginal cost of a call, text or data is so trivial, and the alternative of Skype is ever present it makes it obvious that the Telcos strategy should be to make the prices low enough for us not to care.

Apple charges good prices for their computers, but outrageously high prices for their RAM. The savvy buyer gets the minimum RAM and upgrades on their own.

Apple has locked in loyal customers, such as me, by providing great products. Competitors have much greater hurdles to crack than the price of memory, so for now just keep buying your memory from somewhere else. Memory (and Hard Disk) retailers should be targeting Apple buyers, particularly for the newer models, and making it easy to find and buy cheaper alternatives.

Many of these businesses are mired in the past, and a new player has the real ability to capture a large share before the incumbents react – and by which time it is often too late.

So what other idiot taxes are there – and more importantly what opportunities present themselves as a result? A recession is a great time to attack.